Tax credits are not the answer

My inbox is overflowing with analysis of last week’s budget and its benefits for the impact investment sector—in particular plans to create a Social Impact VCT (SIVCT).  Following the announcement, the sector praised the Chancellor for these proposals, which are only the most recent of many which this Government and its predecessor have implemented since the early noughties.  The first was Community Investment Tax Relief (CITR), originally proposed by the Social Investment Task Force (SITF) but the pace of goodies just keeps flowing.  Social Investment Tax Relief felt like it was proposed just yesterday—my records show it was first floated in early 2013 and implemented last summer.

It is great for the impact investment sector to be getting so much attention.  One cannot doubt the goodwill of politicians in levelling the playing field with the mainstream, and all these initiatives create a favourable back-drop for those of us involved in intermediating capital to organisations which generate high social impact.  This is indisputably helpful in our conversations at ClearlySo with the HNWIs at the core of our angel investment activity.

But I warn against expectations that this will bring about a sudden boom.  Observers who wish the sector to grow faster (frankly, I think it is growing pretty fast already), or who think such funds will solve a meaningful portion of the social problems facing British society today will be disappointed.

I have read many studies which summarise investor’s views that tax credits would encourage them to invest in a particular way, but little evidence that they actually do.  They lower the cost of investment for the wealthy with available liquid assets, but I contend they rarely change the amounts invested.

Perhaps we should consider, by example, what the VCT instrument has done for UK venture capital investing, which seems the most appropriate comparator for the SIVCT.  VCTs were introduced in 1995 to encourage entrepreneurialism in Britain and made far more attractive in subsequent years.  During this time most venture funds have performed abysmally (based on BVCA data).  In fact, they seemed to have turned negative right after the launch of VCTs!  One might not want to suggest causality, but there is an argument that the new fund inflows might only have inflated prices, thereby depressing returns.  During this period venture leaders such as 3i and Apax Partners left and drifted into much larger deals.  VCTs have thus not transformed the venture VC industry—and they will not transform impact investing.

If tax credits are not the answer, what might be?  Perhaps an analysis of the five original recommendations of the SITF provides some guidance.  CITR (a tax credit) has been disappointing.  Disclosure by banks and greater latitude for foundations has had practically no impact.  CDFIs are progressing patchily but only with a large subsidy.  The sole big win was Bridges Ventures, now a thriving impact investments firm—the beneficiary of the recommendation to “set up Community Development Venture Funds”.  The Government invested £20m (half the fund) on a first loss/capped return basis!  This meant the fund could lose half its value before investors suffered any loss and was critical in getting early support for this novel concept.  Bridges has since thrived.

So enough of tax credits which are unlikely to draw in more capital.  Money for first-loss guarantees will cost less and be far more effective in galvanising the sector because it deals with the key issue investors really face—the perception of high risk due to the novelty of impact funds.

First published in Third Sector in April 2015.

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